Five Things to Know about Taking Your RMD

When you retire, the government makes you take money out of your IRA, it's called Required Minimum Distributions RMDs.

We all want to have enough money to retire with. We also have to remember about paying tax on that money as well.

 

An RMD is a Required Minimum Distribution.  That’s the money that you’ve saved up in an IRA or a 401(k) for all these years.  Remember how you got a tax deduction for saving that money?  Well, that was only temporary and the time will come when the IRS wants their tax money back!  Here’s what you need to know!

 

Number 1:  Required Minimum Distributions (RMDs) start at age 70 and 1/2.  If you turn 70 on June 30th, you need to take an RMD distribution that same year.  If you turn 70 on July 1st, you can wait until next the year.

 

Number 2:  If you screw up and miss the December 31st deadline the first year, you still have until April 1st of the next year to get it done.  That’s only good for the first year though.  The downside to taking your distribution on April 1st  is – you still have to take your second distribution by December 31 of that year.  That means you’ll be hit with two years of  RMD income on your tax return instead of just one.

 

Number 3:  If you don’t take your RMD, the penalty is 50% of what you should have taken out in the first place.  Fifty Percent!  Let’s say you have $500,000 saved up in your IRA.  The first year RMD on that account should be $18,248.*  If you didn’t take your RMD, the tax penalty would be $9,124.  That’s not a typo.  You’d pay over nine thousand dollars as a penalty for not taking your RMD.    Ouch!  As as you can see, it’s really important to make sure you take your RMDs!  (Sounds kind of like a vitamin, doesn’t it?)

 

Number 4:  People often ask me if they can take more out of their accounts than the RMD.  The answer is yes you can!  It’s your money, you may take as much of it out as your want, you just have to pay the tax on it.  The RMD is just the minimum that you’re required to take.

 

Number 5:  But if you do take out more than the RMD, you can’t apply that amount to the RMD that you need to take out next year.  For example:  let’s say that instead of taking out $18,248 like we did in that earlier example, you took out $30,000.   Your RMD calculation for the next year would be $17,736.  You’d still have to take the whole $17,736, you couldn’t apply the extra $11,752 that you took the year before to only take $5,984.

 

So if you’re nearing 70 and 1/2, be sure to consult your financial advisor to make sure that you are receiving your Required Minimum Distributions on time to avoid a penalty.

 

*Using the Uniform Lifetime Table for RMD distributions, the distribution period for someone who is 70 years old is 27.4.  To compute the RMD on $500,000 take $500,000 divided by 27.4 = $18,248.

 

**Using the Uniform Lifetime Table for RMD distributions for someone who is 71 years old with $470,000 remaining in their IRA you’d take $470,000 divided by 26.5 to get $17,736.

 

 

Death, Taxes and IRAs

IRAs are taxable after you die.

When people talk about “death” taxes, they usually mean “estate” taxes.  Now, for 2017, there is no federal estate tax if your estate is under $5,490,000.  So for most people, you don’t have to deal with estate tax.  But IRAs are a different animal!

 

An IRA is considered to be taxable income.  So – if you die, your beneficiary will have to pay tax on that IRA money.  So, maybe you don’t care – since you’ll be dead anyway.  But if you do care about leaving a taxable legacy to your heirs, here’s a few things to think about.

 

1.  Roth IRAs are not taxable.  Not to you, not to your heirs.  (I always like Roth IRAs.)

 

2.  A lot of people sign up for IRAs but they don’t know who the beneficiary should be (or they don’t have all the information they need to complete that part of the paperwork.)   When they sign up they just put “estate” down in the beneficiary box.   This is usually a bad thing.  What happens is that your heirs wind up having to file a form 1041, an Estate and Trust tax return.  Now, if you Google “estate tax” you’ll probably find all the tax rates on estates – and you’ll read the tax brackets for if you have over $5,450,000.   (And that’s a form 706 – it’s a different animal.)

 

The 1041 form for income tax on estates and trusts is for the income earned by the estate – which includes your IRA income.  The first $2,550 is taxed at 15%, the next bracket up to $6,000 is taxed at 25%, the next bracket up to $9,150 is at 28%, then up to $12,500 is at 33%, and anything over that is $39.6%.  It doesn’t take a whole lot of money to kick your IRA income into the top tax bracket!  Just to give you a comparison – a single person won’t hit the 39.6% tax bracket until he or she reaches $418,400 in taxable income.

 

So what does this mean?  Well, if your heirs aren’t rich, they’re going to be better off if they inherit your IRA directly from you instead of from your estate.

 

3.  If your goal is to leave a legacy to your children – life insurance is better than an IRA.  (I can’t tell you how much I hate sounding like a life insurance salesman but it’s true.)  Your IRA is your retirement account – it’s supposed to be money for you to spend during your retirement.  In a perfect world, you spend it all before you die.  (And of course, have enough to enjoy a long and happy retirement.)  Life insurance provides your loved ones with tax free cash after you die.

 

This is really a personal decision on your part.  Do you want to leave something for the kids or not?   For some people that’s a major priority, for others, not at all.  It’s your choice.  But not matter what you decide, be sure to work with your financial advisor to make sure your heirs are properly listed as beneficiaries to your taxable retirement accounts.

The Three Sexiest Retirement Savings Strategies

Great retirement planning is sexy!

Start planning now to have the retirement you choose, not the one that’s forced on you.

 

I just used the words “sexy” and “retirement” in the same sentence and I’m serious! Everybody needs to save for retirement, we all know that. That’s not sexy, that’s just a fact of life. But if you can get free money or tax free income while you’re saving – well, that makes it downright sexy!

 

So what are the three sexiest retirement savings strategies? The employer match, the Roth IRA, and the solo 401(k). Let me explain why.

 

First: The Employer Match. An employer match is where your boss matches a certain amount of your 401(k) contribution. For example: let’s say you make $50,000 a year and your employer has a 3% match. Three percent of $50,000 is $1,500. Your employer will “match” what you put in, so you’ll need to contribute at least $1,500 into your 401(k) to get the $1,500 from your employer. That’s free money to you! When you contribute to your 401(k) – it’s not counted on your tax return, but you still pay social security and medicare withholding on that money. The employer match has no withholding on it. It’s a straight contribution to your retirement savings. Free money. Free money is sexy! If you work for a company with an employer matching program, you need to get in on the action!

 

Second: the Roth IRA. A Roth IRA has no up front tax benefits to it. You put the money in after you’ve already paid tax on that money. What’s sexy about the Roth is that your investment grows tax-free. And more importantly, when you retire – you take that money out tax-free! I cannot stress just how valuable being able to access tax-free income during your retirement is! The Roth is probably the most accessible of the retirement options I’m talking about, but there are limits as to who can contribute to a Roth. Here’s a link to the IRS website showing the current limitations: Roth Limitations

 

Third: The Solo 401(k).  If you’re a solo business owner, or you and your spouse own a business together, then a solo 401(k) might be the plan for you.   For one thing – you can contribute up to 100% of your earned income (up to the maximum contribution allowed) to your 401(k).  This is great for folks who are actively trying to “catch up” on their retirement savings (and also happen to have another source of income!)

 

A solo 401(k) also allows you to make an “employer match” of up to 25% of your earned income.  You see, when you work for yourself, you’re both the employer and the employee!

 

So how do those numbers work?  Let’s say you own an S Corporation and you pay yourself a wage of $50,000. You can make an elective deferral – that’s what they call your 401(k) contribution – of up to $18,000 (or $24,000 if you’re 50 or older.)   That means your W2 is going to show that you have $32,000 of taxable income.  ($50,000 minus the $18,000 that you applied towards your 401(k).  You’ll have paid social security and medicare taxes on the full $50,000 – because you still pay the FICA on your retirement savings, just like if you worked for someone else.

 

But now, you’re still allowed to make an employer match of up to 25% of your earned income – in this case, I mean wages.  So, you could contribute another $12,500 towards your 401(k) as an employer match TAX FREE!  You don’t pay regular income tax on that money because it’s a business expense, right?  So it’s deducted from your business income as an employee benefit (where you’re the employee.)   And, since it’s an employer match – you don’t pay FICA either.  How cool is that?

 

Saving for retirement is necessary for everybody, but if can manage to swing tax free savings or tax free income it makes saving much more exciting.  You might even call it sexy!

 

 

Three Myths About Income Tax in Retirement

Active retirement old people and seniors free time group of four elderly men having fun and playing cards game at park. Waist up

 

 

Do you still have to pay income tax after your retire?  The short answer is: YES!

 

I’m not sure why, but there seems to be a myth floating around about seniors not paying taxes. I’ve always had to deal with seniors in trouble for not filing tax returns when they needed to, or not paying tax on their IRAs, but lately I’ve been hearing the age myth. Three times in the past three weeks I’ve heard real people say the following things:

 

“Now that I’m 65 I don’t have to pay self employment taxes on my 1099 income.”

“What do you mean I need to be concerned about required minimum distributions, I won’t have to pay tax after I’m 70 anyway?

 “I won’t need you to do my taxes anymore now that I’ve turned 80. There’s no taxes after 80.”

 

The bad news is: those statements are all false!   The IRS doesn’t really care how old you are.  They still want your money.  So how do some of these myths get started in the first place?   Well, some states don’t tax your retirement income.  So if you live in one of those states, it’s easy to assume that the IRS doesn’t tax it either, but the IRS does tax retirement income, and they don’t care how old you are.

 

Myth 1, not paying Social Security tax after age 65:  Once you start receiving Social Security benefits, it’s easy to assume that you won’t be paying into Social Security anymore.  But–you do.  Actually, if you’re still working after your full retirement age you might even increase your Social Security benefits.  It all depends upon your circumstances, but you’ll want to check with Social Security to make sure that you’re being credited for your Social Security contributions.

 

Myth 2, no taxes after age 70:  After age 70 1/2 you are required to start taking money out of your IRAs.  It’s called Required Minimum Distributions (RMDs)- and that money is taxed.  The quick and dirty calculation to figure your first year RMD is to take the total dollar amount of the money you have in all of your IRAs and divide by 28.  Now, this is a quick and dirty calculation.  Different ages, and different situations can get you different results.   If you want to compute an RMD for a different age, try the Kiplinger calculator:  http://www.kiplinger.com/tool/retirement/T032-S000-minimum-ira-distribution-calculator-what-is-my-min/index.php

 

For many people over 70, you don’t stop paying taxes, you actually pay more in taxes.  If you don’t know about the RMDs and you need to be taking them, there can also be some pretty hefty penalties.

 

Myth 3, not paying taxes  after age 80:   I don’t know where that came from.   (Actually, I heard it from my mother-in-law who heard it at the senior center.  But I don’t know where it started.)   Many seniors don’t pay tax because their income is low enough not to pay, and they aren’t required to file.  But they’re not paying tax because of their low income, not because of their age.

 

And even if you’re not required to file, I still recommend submitting a return anyway to prevent identity theft.

Is My Social Security Income Taxable?

Do I have to pay tax on Social Security?

Photo by Jan Roberg.

People often ask me if their Social Security income is taxable.  No, sorry, I just lied.  When I finish preparing  a tax return for someone on Social Security I’ll often hear, “What do you mean my Social Security is taxable? ”  People who say that are usually angry when they say it too.  But, for many people, Social Security is taxable.

So how do you tell if your Social Security is going to be taxed?  Here’s the quick and dirty way to figure it out.  First, take half of all of the Social Security income you get and add that to all of the other income you get.  If you’re single and the amount is over $25,000 you’ll start getting hit with tax.  If you’re married filing jointly—then you’ll start getting hit at $32,000.  If you’re married-filing separately and don’t live apart—then it’s all taxable.

So this can totally mess up your tax rates.  For example—let’s say you ‘re currently in the 15% tax bracket and you haven’t crossed into “Taxable Social Security Land” yet, but you’re right on the border.  You want to take a really nice vacation and it’s going to cost you $10,000.  How much money do you need to take out of your IRA to go on vacation and pay the income tax?

Well, you know you need 15% more for the tax so let’s say you take out $12,000.

$12,000 X 15% = 1800

That means that you’ll have $10,200 for your vacation, right?  (12,000 IRA – 1,800 income tax = 10,200 vacation money)

Looks good, except it’s wrong.  See, if you’re on that border, then half of the $12,000 is going to go into the taxable Social Security pile.  So instead of paying 15% on $12,000 you’re paying 15% on $18,000; that’s another $900 in taxes.  ($18,000 X 15% = $2,700    and    $2,700 – $1,800 = $900) 

Now you don’t have enough money to pay for your vacation.  You’ll need to be taking more out of your IRA and then even more of your Social Security will be taxed.

Because taking that distribution makes your Social Security Taxable—your real tax rate is 22.5% instead of 15%.

$2,700 tax divided by $12,000 distribution = 22.5% tax rate

For lots of people, there really isn’t much you can do.   If your income is high enough, you’re stuck with your Social Security being taxed and there’s no way out.   But for some folks—you can plan ahead to avoid this bumped up tax—or at least try to reduce it.  You’ve got to know about the tax though if you’re going to plan ahead for it.  If you want help figuring out if your Social Security is taxable, give us a call.

How Much Can I Contribute to My 401(k)?

Piggy Bank

Photo by Danielle Elder on Flickr.com

Good question! Starting in 2012, you can put up to $17,000 away for retirement in a 401(k) plan. This figure also holds for people who have 403(b) plans and any of the 457 plans as well. If you happen to be over 50, you’re allowed what’s called a catch-up contribution so you can add an additional $5,500, making your total 401(k) contribution $22,500 for 2012.

Remember, money that goes into a 401(k) is tax-deferred so although you’re not paying tax on the money now, you will pay tax on it when you do withdraw it for retirement. If you take the money out of the plan before you reach the age of 59 ½, there’s a 10% additional penalty on top of the regular tax that you’ll pay. As much as I think 401(k) plans are a great deal, if you think that you’re going to need the money before you retire, you might want to re-think your contribution.

A good rule of thumb is that a person should be contributing 10% of his or her income into a retirement program. If you can afford 15%, that’s better, but 10% for sure.

Some companies have what’s called a Roth 401(k)—it basically works like a Roth IRA: you pay your income tax on your retirement plan contributions now, but when you take the money out later it’s tax free. Roth 401(k) plans have the same limits as regular 401(k) plans. If you have access to one of these plans you should seriously consider using it. For anyone who is in a 15% or lower tax bracket, choosing the Roth should be a no-brainer. If you’re in the 25% tax bracket and under 40, I’d still go with the Roth. After that, I’d start doing some serious considerations of what my future plans were, how early I’d want to retire, and other factors.

If your income is below $58,000, you can make fully deductible IRA contributions in addition to your 401(k) contributions (For married couples it’s $92,000.) This gives you some wiggle room. If you’re not comfortable committing to your 401(k) contribution rate, you can make up the rest with an IRA if you’ve got the funds at the end of the year.

If you haven’t started saving for retirement yet, this is the time to start.

IRAs for Dummies

Writer

 

Okay first and foremost, you’re not a dummy!  But I wanted to make a simple post with simple explanations about IRAs.  This isn’t the be all end all of IRA stuff.  But hopefully it will give you a little clue about them.

A traditional IRA lets you put money away for retirement and you can get a tax deduction for the money that you put into the IRA.  For example:  if you’re in the 25% tax bracket and you put $1,000 into an IRA then you will save $250 in taxes for the year you put the money in.  (The tricky part is that there are limits as to how much is deductible if you or your spouse have a retirement plan at work.  There are also complications if you’re using the married filing separately status.  I’m not covering that here.  If this sounds like you, give me a call and I can help you figure it out.)

A Roth IRA lets you put money away for retirement but you don’t get a tax deduction for the money you put in.  $1,000 into a Roth IRA gives you no tax savings.  (There are income limits for contributing to a Roth, the phase out starts at $167,000.  If you’re under that income level, you’re fine.)
Generally, the most you can contribute to an IRA in a year is $5,500.  If you’re married, you can contribute $5,500 for you and $5,500 for your spouse, even if your spouse doesn’t work.  You can’t put more money into an IRA than you earned (so if you only made $3,000 that’s going to be your maximum contribution.)   If  you’re over 50 years old, you can contribute up to $6,500 to your IRA.
Remember, the $5,500 is a maximum.  It’s fine to contribute less.  Most accounts are going to want at least a $1,000 to open, but you don’t have to have $5,500 to put into an IRA. Its not an all or nothing kind of investment.
When you take money out of your traditional IRA, the money you take out is taxable.  So, once again if you’re in the 25% tax bracket and you take $1,000 out of your IRA then you’ll pay $250 in taxes.  The concept is kind of like:  take a tax deduction now/pay taxes later.  Here’s where it’s tricky…if you take the $1,000 out before you are 59 1/2, not only will you pay the $250 in taxes, but you’ll also pay a 10% penalty making the total tax you pay $350.  There are exceptions to the penalty if you use the money to buy a house or pay tuition.  You will pay the tax no matter what, but sometimes you can escape the penalty.
With the traditional IRA you are playing a gambling game.  You’re betting that your taxes are higher now and will be lower when you retire.  That’s a good bet for many people.  So the traditional IRA is a good thing.
When you take money out of your Roth IRA, the money you take out is not taxable.  So, if you take out $1,000 from your Roth and you’re in the 25% tax bracket, you will pay zero tax on that $1,000.  If you take the $1,000 out before you turn 59 1/2, you may pay a 10% penalty on the earnings but not on the whole $1000.  Roth IRA means tax-free income later.
I really like the Roth IRA for a couple of reasons:
  1. It’s especially good for young people.  The Roth is a great savings tool that can be used for buying a home and paying college tuition.  If you invest in a Roth when you’re in the 15% tax bracket but wind up taking the money out when you’re in the 25% tax bracket:  zowie!  You win!  It’s like a little tax bonus.
  2. Even if you’re more mature and already in the 25%  tax bracket or higher, I still like the Roth.  When you’re retired and receiving social security payments, your social security isn’t taxable until you cross a certain income threshhold.  Once you cross that line, your social security becomes taxable and it’s like you’re paying double taxes.  For example:  let’s say your pension and social security put you right at the line where if you make any more money your social security would be taxable.  Once you cross that line you’ll pay tax on your social security income.  If you take money out of your traditional IRA, let’s use the $1,000 example again, and you’re in the 15% tax bracket, you won’t pay 15%–you’ll pay even more because now your social security will be taxed too.  It’s not exactly double, it’s more like one and  a half times more.  (Kind of a funky equation.)  Bottom line:  once you start receiving social security payments, extra income is actually taxed at an even higher rate than your real tax rate because they start taxing your social security.    Ouch!  Ask any senior citizen who’s been hit with this.  It hurts.
  3. Now  if your retirement income is so far over the threshold that you don’t need to worry about additional tax (because you’ve maxed out your taxable social security), or if it’s nowhere near the threshold, then it’s not really an issue for you.  But for many seniors, extra taxable income can be a big problem for them.  The Roth IRA can be a real lifesaver when you’re older.
If it’s not completely obvious yet, I’m a big Roth fan.  That said, if you need a tax deduction now, then traditional IRA is the way to go.  For example:  one  year, I needed to lower my personal income by $310 to claim a $2000 tax credit.  That’s a no brainer, of course I spent $310 on a traditional IRA to save $2,000.  I put the rest of my retirement money into a Roth.  You can do stuff like that when and if you need to.
There’s so much to know about IRAs and it can be really confusing.  This little post is just the tip of the iceberg.  For detailed information about IRAs, the IRS has a book called Publication 590.  Here’s a link to it:  Pub 590
Okay, I confess, that publication looks a little intimidating.  It’s 110 pages long.  But if you look at page one, the chapters and sections are set up based upon the questions people ask.  Look for your question and it will tell you the right page to find your answer.  It’s not so scary when you know that in advance.

How Much Should I Put into my 401(k)?

How much should I save with my 401(k)?

The more you save for retirement, the more you’ll have when you retire.

 

Updated June 10, 2016.

 

One question I hear all the time is, “How much should I put into my 401(k)?”   A good answer to that question is, “as much as you can.”  But how do you figure that out?

 

For 2016, the maximum amount that you can put into your 401(k) is $18,000, unless you’re 50 years old or over, then you can put $24,000 per year in.  If you can afford to put the maximum into your retirement plan, I recommend you do so.  I have never yet heard anyone complain of having too much money for their retirement.

 

But what if you can’t afford to put $18,000 into your retirement?  What if that’s all you make?  How do you determine how much to save?  As much as I always want to encourage people to put money into a retirement plan, if your financial situation is tight, and you might be forced to take that money out within the same year, don’t even put it in.  The very first thing you want to do is have a little cushion in a savings account.  If the car breaks down, or the roof needs a repair, you’ve got a little back up.

 

Let’s say your annual income is $30,000 a year and you have no savings whatsoever.  Make a goal of saving 10% of your income.  That’s 10% of $30,000, not 10% of your take home pay.  To do that, you’d need to save $60 per week to save $3,000 in one year.  (I gave you two weeks of vacation there.)  If you can’t live with that, adjust down a little until you find an amount that you can save regularly without hurting yourself.

 

Once you’ve got a little savings cushion, then you can start the retirement savings.  I always recommend that if your employer has a matching program, put in as much money as your employer will match.  For example:  let’s say your income is still $30,000 and your employer has a program where he’ll match what you put into your 401(k) up to 5% of your income.  If you put in $1,500, he’ll match it with $1,500.  That’s a 100% return on your investment.  If you put in $3,000, he’ll still only match with the $1,500.  If you can afford to save extra, that’s great, but the priority is the match.

 

Another consideration when deciding upon retirement contributions is reducing your income.  Suppose you’ll have a graduating senior in the spring.  401(k) contributions would lower the income reported on your tax return, which could impact your scholarship potential.  On the other hand, if you already have a child in college, education credits start phasing out at $80,000 ($160,000 if married filing jointly).   If you’re near a tripping point for a tax credit or deduction, it might make sense to increase your 401(k) contributions so that you can qualify for the credit.   Check with your tax professional to see what works best for you.